Deduction for Interest on borrowed capital
Introduction
Interest on borrowed capital is allowed as deduction while computing the profits and gains from business or profession. However, if borrowings have been made for acquisition of a capital asset, the interest, pertaining to the period before asset is put to use, shall be capitalized with the actual cost of such capital asset.
1. Conditions to claim deduction
Where an assessee borrows money to acquire an asset, amount of interest, pertaining to the period before asset is put to use, shall be added to the actual cost of such asset in accordance with provisions of Section 39(1)(a).
After an asset is put to use, the interest on the capital borrowed, pertaining to the period after such asset is put to use, shall be allowed as deduction under this provision. Similarly, interest on borrowings taken for operational activities shall be allowed as deduction under this provision. ICDS IX (Borrowing Cost)provides for Capitalisation of borrowing cost incurred for acquisition of qualifying capital assets. But it doesn’t provide any treatment of other borrowing cost. However, from provisions of ICDS IX it can be interpreted that borrowing costs, other than those which are capitalised as a part of the cost of the qualifying asset, shall be allowed as deduction while computing income from business or profession in the tax year in which such cost is incurred.
For the purpose of deduction under this provision, the term borrowing shall include periodical payment of recurring subscription by the shareholders or subscribers in Mutual Benefit societies, which fulfils the prescribed conditions.
The deduction under this provision shall be allowed on fulfilment of following conditions.
1.1. Assessee has borrowed capital
The interest paid by the assessee is allowed as deduction if it is paid in respect of capital borrowed for the purpose of business or profession. The expression ‘capital’ shall mean money and not any other asset. Thus, purchase of a capital asset on a long-term credit with a stipulation for payment of interest on the unpaid balance of the price does not amount to the borrowing of capital within the meaning of this clause. Such a transaction is not a loan transaction. Thus, interest payable on such credit purchases is not deductible under this provision but may be deducted under general provision of Section 34(1).
Interest paid to the directors on the amount of their undistributed salaries is not deductible under this clause as there is no borrowing
1.2. Borrowings used for business
The deduction for interest paid by the assessee on the capital borrowed is allowed as deduction provided the borrowings have been used for the purpose of business or profession. The expression ‘for the purpose of business’ is much wider than ‘for the purposes of earning profit’. It may include
1.3. Interest is paid or payable on borrowing
If assessee maintains books of account on cash basis of accounting, interest is deductible on payment basis. If assessee follows mercantile system of accounting, interest on borrowed capital is deductible on accrual basis. However, interest payable to the following institutions shall be allowable only on payment basis by virtue of Section 37:
(a) Public Financial Institution
(b) State Financial Corporation
(c) State Industrial Investment Corporation
(d) Scheduled Banks
(e) Co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank
If interest, in the above cases, is paid on or before the due date fixed for furnishing return of income for the tax year in which the liability to pay interest has accrued, deduction is allowed in the year of accrual itself. If interest is paid after the said date, deduction is allowed in the tax year in which the date of payment falls.
2. Interest expense to be disallowed
2.1. Interest paid without deduction of tax
Main article: Disallowance for TDS default
Interest paid outside India is not allowable as deduction by virtue of Section 35(b)(ii) if tax has been not deducted at source or after deduction it has not been deposited to the credit of Central Government. If interest is paid to a resident person without deduction of tax at source, 30% of such interest shall be disallowed under Section 35(b)(i).
2.2. Excessive Interest
Main article: Deduction for interest paid to Associated Enterprise
If an Indian company (or a Permanent Establishment of a foreign company in India), incurs any expenditure by way of interest or of similar nature exceeding Rs. 1 crore in respect of any debt issued by a non-resident, being an associated enterprise, the excess interest shall not be deductible. The excess interest shall mean interest paid in excess of 30% of earnings before interest, taxes, depreciation and amortisation of the borrower in the tax year
The amount of such interest expenditure, which is not deductible from business profits of current year, shall be carried forward, upto 8 tax years, to the following tax year and shall be allowed as a deduction against the income from business or profession assessable for that year.
2.3. Interest paid to earn exempt income
Main article: Section 14 disallowance
If borrowed money is utilized to make investment and the resultant income therefrom is exempt from tax, the interest and all other attributable expenses shall be disallowed in accordance with provisions of Section 14
2.4. Excessive interest paid to the partners
Main article: Remuneration or interest to partners
Any payment of interest by a firm to a partner is allowed as deduction if rate of interest does not exceed 12% per annum and it is authorised by the partnership deed.
2.5. Interest paid by an AOP or BOI to member
Main article: Interest payable by AOP or BOI to members
No deduction is allowed in respect of any interest paid by an Association of Person or Body of Individual to its member.
2.6. Interest on owned capital
As no one can borrow from himself, interest on own capital is not deductible. In other words, if assessee has debited the interest on own capital, calculated on notional basis, to the statement of profit or loss, it shall be disallowed and added back to calculate the taxable profits of business or profession.
2.7. Interest on money borrowed for payment of tax
Interest on money borrowed to pay income-tax is not allowable as deduction under this provision. Similarly, interest paid for deficit in or deferment of advance tax or for late filing of return is not allowable as deduction under this provision
References
CIT v. Saraswati Chemicals and Allied Industries (P) Ltd. (2001) 249 ITR 235 (Del.)].
Kirloskar v. CIT 228 ITR 674
CIT v. Malayalam Plantations Ltd. (1964) 53 ITR 140 (SC)].
National Engg. Industries Ltd. v. CIT [1978] 113 ITR 252 (Cal.), Roopchand Chabildass & Sons v. CIT [1967] 63 ITR 166 (Mad.)
This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.